We put forward an equilibrium model that links the cross-sectional variation in expected equity r... more We put forward an equilibrium model that links the cross-sectional variation in expected equity returns to …rms'life cycle dynamics. In the model, assets have di¤erent exposure to short-run and long-run consumption risks (Bansal and Yaron (2004)). An econometrician who uses the conditional CAPM regression to predict asset returns will obtain high 0 s for assets that are highly exposed to low-frequency risks. Growth options have lower exposure to long-run risks than value assets because cost of exercising the growth options is highly sensitive to persistent uctuations in aggregate consumption and, therefore, provides a hedge against risks of assets in place. Small …rms exhibit high exposure to long-run risks as they are more likely to fail in bad times and, hence, in equilibrium carry a high risk premium. We calibrate the model and show that it is able to account for the observed pattern in mean returns on size and book-to-market sorted portfolios, as well as the failure of the C...
ABSTRACT Abstract We consider an exchange economy with a continuum of agents, each of whom,is sub... more ABSTRACT Abstract We consider an exchange economy with a continuum of agents, each of whom,is subject to idiosyncratic endowment,shocks. We study e‐cient alloca- tions subject to two constraints: limited enforcement of flnancial contracts, and private information about the predictable component of the future endowment process. In our economy the immiseration result, common in this literature, does not hold, and a nontrivial steady state distribution exists. We calibrate our model to match the basic aggregate moments of the US economy, and flnd evidence that the e‐cient allocation implied by our model captures some of the very key features of observed partial risk sharing among households. Such crucial empirical features cannot be explained by existing models of endogenous incomplete markets. Keywords: Limited Enforcement, Private Information, Risk Sharing, Con- sumption Inequality JEL Classiflcation:D31, D63, D91, E21,G22 We would like to thank Marco Bassetto, Michele Boldrin, V. V. Chari, Mariacristina De Nardi,
We put forward an equilibrium model that links the cross-sectional variation in expected equity r... more We put forward an equilibrium model that links the cross-sectional variation in expected equity returns to …rms'life cycle dynamics. In the model, assets have di¤erent exposure to short-run and long-run consumption risks (Bansal and Yaron (2004)). An econometrician who uses the conditional CAPM regression to predict asset returns will obtain high 0 s for assets that are highly exposed to low-frequency risks. Growth options have lower exposure to long-run risks than value assets because cost of exercising the growth options is highly sensitive to persistent uctuations in aggregate consumption and, therefore, provides a hedge against risks of assets in place. Small …rms exhibit high exposure to long-run risks as they are more likely to fail in bad times and, hence, in equilibrium carry a high risk premium. We calibrate the model and show that it is able to account for the observed pattern in mean returns on size and book-to-market sorted portfolios, as well as the failure of the C...
ABSTRACT Abstract We consider an exchange economy with a continuum of agents, each of whom,is sub... more ABSTRACT Abstract We consider an exchange economy with a continuum of agents, each of whom,is subject to idiosyncratic endowment,shocks. We study e‐cient alloca- tions subject to two constraints: limited enforcement of flnancial contracts, and private information about the predictable component of the future endowment process. In our economy the immiseration result, common in this literature, does not hold, and a nontrivial steady state distribution exists. We calibrate our model to match the basic aggregate moments of the US economy, and flnd evidence that the e‐cient allocation implied by our model captures some of the very key features of observed partial risk sharing among households. Such crucial empirical features cannot be explained by existing models of endogenous incomplete markets. Keywords: Limited Enforcement, Private Information, Risk Sharing, Con- sumption Inequality JEL Classiflcation:D31, D63, D91, E21,G22 We would like to thank Marco Bassetto, Michele Boldrin, V. V. Chari, Mariacristina De Nardi,
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